Within a fortnight last month, Australia and New Zealand placed opposite bets on their economic futures. The Reserve Bank of Australia raised interest rates to 3.85 per cent. Across the Tasman, the Reserve Bank of New Zealand held at 2.25 per cent, with Governor Anna Breman signalling that monetary policy would stay loose for some time.
So, one economy is apparently running too hot while the other cannot get off the floor. Surely, they face different problems requiring different medicine?
Well, not quite. Both economies are constrained by the same underlying weakness: a productivity decline so marked that even modest growth now generates inflation.
Productivity has slowed across the developed world, but the consequences bite harder in small, remote economies. Without deep capital markets or major technology sectors, Australia and New Zealand once compensated for those structural disadvantages through relentless reform. But when the reforming stopped, their old challenges reasserted themselves.
Last August, the RBA cut its trend annual labour productivity growth assumption from 1.0 per cent to 0.7 per cent. It sounded like a technical revision, but it mattered enormously. With trend productivity that low, real output can barely grow at all. What registers as 2 per cent growth is largely nominal: prices rising rather than output expanding. Push demand much beyond that, and inflation will accelerate.
The result is sobering. In the 1990s, 2 per cent growth would have counted as disappointing. Today it is the ceiling.
New Zealand’s situation differs from Australia’s in timing rather than substance. The RBNZ can afford low rates because the economy contracted in 2024 and recovery remains fragile. Thus there is some slack, but it exists because the economy has been knocked down, not because it has room to run.
Even so, New Zealand’s inflation lifted to 3.1 per cent in the December 2025 quarter, nudging above the RBNZ’s target band. Once that slack is absorbed, New Zealand will find its own speed limit has fallen just as far as Australia’s – and the RBNZ may be forced to lift interest rates.
Consider how far New Zealand’s economic performance has slid. In the 1960s, partly boosted by Korean War commodity prices, New Zealand ranked among the richest nations on earth. Today, its GDP per capita sits below the OECD mean. Average wages have fallen to roughly a third below Australia’s. Near record numbers of New Zealanders are crossing the Tasman. Never mind that Australia’s own
economic performance is hardly stellar these days.
So, how did both countries get here? By preferring comfort over reform and reaching for short-term fixes rather than doing the hard work of lifting productivity.
Immigration was the most visible fix because it lifts overall economic output. Australia’s net overseas migration peaked at 556,000 in the year to September 2023. Many new arrivals on both sides of the Tasman are absorbed into hospitality, retail and aged care. Headline GDP rose, giving governments a comforting number to report. But that growth was largely arithmetic – more people producing more in aggregate – rather than evidence that the economy was becoming more efficient.
Australia endured seven consecutive quarters of declining real GDP per person, the longest such run on record. Some of that decline reflects composition – new arrivals concentrated in lower-wage sectors pull down the average even when existing residents are no worse off. But treasurers do not report median incomes of the non-migrant cohort. They report headline GDP, and the headline flattered the reality.
Housing made it worse. Around two-thirds of Australian household wealth sits in residential property. Planning restrictions and tax settings have channelled savings into bricks rather than businesses. Rising house prices made homeowners feel richer and spend accordingly, stoking demand while doing nothing to expand supply.
The story is similar on the other side of the Tasman. New Zealand households spend around a quarter of their disposable income on housing, among the very highest proportions in the OECD.
Commodities also played a role. Australia rode iron ore and coal while New Zealand rode dairy and meat. When prices run high, export revenues surge and the currency appreciates, squeezing every other industry.
Immigration, housing and commodities each bought time and made the economies look better than their productivity records would suggest. But none of these factors raised output per hour. And the time these factors bought has largely run out.
Both countries once understood the need to lift productivity. In the 1980s and 1990s, Australia and New Zealand stood at the global forefront of economic reform. Hawke and Keating floated the dollar, cut tariffs and shifted wage-setting from centralised awards to enterprise agreements. They brought the union movement along through the Prices and Incomes Accord, giving reform social consent and making it politically durable.
Across the Tasman, Roger Douglas removed agricultural subsidies virtually overnight, and later Ruth Richardson reformed the labour market more radically than anything Australia attempted.
The payoff in both cases was real. In Australia, productivity growth in the 1990s averaged 2.1 per cent. Keating had warned that without reform, Australia would become a “banana republic.” Douglas said New Zealand faced third-world status. They were right, and they acted.
But then both countries stopped. The GST in 2000 was arguably Australia’s last major structural reform. New Zealand even partly reversed course.
The reasons for this ‘reform holiday’ are obvious. Why undertake the political pain of further change when rising house prices keep voters content? Why restructure taxation when migration keeps headline GDP ticking upward? Why not just muddle through somehow?
In this context, both central banks are doing what central banks should do: pursuing price stability within their mandates. The failing lies not with them but with governments that have left monetary policy to manage a productivity crisis that interest rates cannot solve.
No doubt, the monetary policy divergence between the RBA and the RBNZ will generate plenty of commentary in coming months.
But that should not distract us from what both countries have in common: that our two countries reformed their way to prosperity a generation ago but have lost the political will to continue deep structural reforms.
No interest rate setting can compensate for that lack of microeconomic reform. It requires leadership of a kind both countries can only pray for.
To read the article on The Australian website, click here.